A montage of bitcoin with the logos of Grayscale and the SEC
A federal appeals court ruled that the SEC was wrong to reject Grayscale’s application to convert its flagship Grayscale Bitcoin Trust into an ETF © FT montage/Dreamstime

Proponents of digital assets were crowing on Tuesday after cryptocurrency asset manager Grayscale scored a resounding legal victory in its efforts to offer a spot bitcoin exchange traded fund, and the price of bitcoin subsequently shot up 7 per cent to nearly $28,000.

But that does not mean investors will be able to run out and buy a Grayscale spot ETF tomorrow. Nor does it immediately doom efforts by the US Securities and Exchange Commission to bring enforcement actions against some of the industry’s biggest players, including crypto exchanges Coinbase and Binance. The story of the watchdog’s efforts to tame what it sees as a financial wild west still has some way to run.

What did the court rule?

A federal appeals court ruled that the SEC was wrong to reject Grayscale’s application to convert its flagship Grayscale Bitcoin Trust, which the SEC approved in 2015, and which holds more than $15bn in bitcoin, into an ETF. The SEC has allowed bitcoin futures ETFs since October 2021 but contended that spot funds were prone to manipulation, since crypto tokens trade on largely unregulated markets.

Judge Neomi Rao wrote in the decision that the SEC’s denial was “arbitrary and capricious because the commission failed to explain its different treatment of similar products”.

“This is a monumental step forward for American investors, the bitcoin ecosystem, and all those who have been advocating for bitcoin exposure through the added protections of the ETF wrapper,” Grayscale said in a statement.

What happens next?

The SEC has 45 days to decide whether to abide by the decision, ask the full federal appeals court in Washington to review it, or take an appeal straight to the Supreme Court. It said on Tuesday that it was reviewing the decision.

Lawyers said Grayscale would have to file a new application for its ETF. But there is no guarantee that it will be approved, despite the court’s decision — the SEC could reject it on other grounds.

Indeed, investors still seem to think that the Grayscale trust’s conversion could get gummed up. One reason Grayscale has long sought to convert its trust into an ETF is that trusts, unlike ETFs, often trade at a discount to their holdings. Even after Tuesday’s ruling, the Grayscale trust was still trading at a 20 per cent discount, a sign that investors are wary that a conversion will happen soon.

Financial reform group Better Markets suggested that the agency could address the court’s concerns another way — by cancelling bitcoin futures ETFs rather than approving new spot products. The ruling “does not change the fact that the bitcoin market is subject to fraud and manipulation or that an ETF would be a serious threat to investors”, said Dennis Kelleher, its chief executive.

What does this mean for other bitcoin ETFs?

The first European spot bitcoin ETF started trading earlier this month. In the US, there are more than a dozen other applications pending, including some from the largest US asset managers. All of them would face similar questions about preventing market manipulation and how to price the asset at the end of the trading day, lawyers said.

Even though Grayscale had successfully challenged the SEC’s decision, there was no legal guarantee that it would jump to the front of the queue for review, said Teresa Goody Guillén, a partner at BakerHostetler.

The most closely watched ETF proposal is from BlackRock, the world’s largest asset manager. It first filed in June 15, and the SEC officially added the BlackRock application to its docket on July 13, followed by similar proposals from Invesco, VanEck and WisdomTree. All of them are coming up for preliminary deadlines this week.

SEC watchers said the commission would most likely impose a 45-day delay that puts the decisions off until mid-October. “I think there’s a pretty reasonable chance that multiple products get approved at once,” said Jeremy Senderowicz, of law firm Vedder Price.

What does the ruling mean for efforts to regulate crypto and digital assets?

Digital asset groups were ecstatic about Grayscale’s win. Coinbase’s chief legal officer Paul Grewal called it “a great moment for the industry . . . while we still believe comprehensive federal crypto legislation is the best way forward, decisions like this are an important step toward the clarity the industry needs”.

Guillén described the Grayscale decision as a “hefty blow to the SEC”.

“This confirms that the SEC’s approach to crypto has opened it up to legal challenges — whether as arbitrary and capricious, outside its statutory authority, improper rulemaking, et cetera,” she said. “It certainly confirms that the courts are holding the SEC accountable to its legal obligations, including the SEC’s approach to crypto.”

The decision could give impetus to those who want to give more power over the sector to another regulator, the Commodity Futures Trading Commission, which oversees derivatives.

“This is a real loss of face for the SEC because of the language the appeals court used to chastise them,” said Lewis Cohen, of DLXLaw.

What happens to the SEC’s enforcement cases against crypto groups such as Coinbase and Binance?

The Grayscale decision was focused on the SEC’s administrative procedures rather than its legal authority to regulate and enforce. So the case has no direct impact on the watchdog’s lawsuits accusing exchanges Coinbase and Binance of violating securities laws.

Those cases were partly called into question by an earlier lower court decision in an SEC enforcement case that involved the Ripple token, when a judge found the company did not violate securities law when its tokens were bought by members of the public on secondary markets. The SEC is appealing against the ruling, but if that decision stands, its effort to regulate digital assets as securities would be weakened.

While legally distinct, the Grayscale decision can be used to further claims that the SEC has been misreading current law, said attorneys for the industry.

“The crypto industry is pointing to this as another example of SEC over-reach . . . it lets them spin it as an agency out of control,” said Lee Reiners, who teaches a course on crypto law at Duke University.

Additional reporting by Stephen Gandel in New York

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